George LeMaitre - Chairman and Chief Executive Officer Joseph Pellegrino - Chief Financial Officer David Roberts - President.

Jason Mills - Canaccord Genuity Chris Lewis - ROTH Capital Joe Munda - First Analysis Lucas Baranowski - Craig-Hallum.

Welcome to the LeMaitre Vascular Q2 2017 Financial Results Conference Call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Mr. JJ Pellegrino, Chief Financial Officer of LeMaitre Vascular. Please go ahead, sir..

Thank you, Heather. Good afternoon and thank you for joining us on our Q2 2017 conference call. With me on today's call is our Chairman and CEO, George LeMaitre, and our President, Dave Roberts. Before we begin, I'll read our Safe Harbor statement.

Today, we will be looking at some forward-looking statements, the accuracy of which is subject to risks and uncertainties. Wherever possible, we will try to identify those forward-looking statements by using words such as believe, expect, anticipate, pursue, forecast and similar expressions.

Our forward-looking statements are based on our estimates and assumptions as of today, July 27, 2017, and should not be relied upon as representing our estimates or views on any subsequent date.

Please refer to the cautionary statement regarding forward-looking information and the risk factors in our most recent 10-K and subsequent SEC filings, including disclosure of the factors that could cause results to differ materially from those expressed or implied.

During this call, we will discuss non-GAAP financial measures, which include organic sales and growth numbers, as well as EBITDA. A reconciliation of GAAP to non-GAAP measures discussed in this call is contained in the associated press release and is available in the Investor Relations section of our Web site, www.lemaitre.com.

I'll now turn the call over to George LeMaitre..

Thanks, JJ. I will focus on three headlines. First, top to bottom, Q2 was a record quarter. Second, XenoSure continues to drive growth and was up 30% organically in Q2, and third, all three of our biologic products set records in the quarter. As to our first headline. We posted several financial records in Q2.

Record sales of $25.8 million, up 15% versus Q2 2016. Record op income of $5.5 million, up 46%. Record net income of $4.6 million, up 78%, record EPS of $0.23, up 69%, and record EBITDA of $6.4 million, up 35%. As to our second headline. XenoSure continues to drive growth and was up 30% organically in Q2 to $5.5 million.

This is just $20,000 shy of XenoSure's reported Q3 2016 record when it benefitted from a competitors back order. And we continue to invest in XenoSure. On June 29 we applied for regulatory approval on Australia. On July 13 the first two implants in our Chinese clinical trial took place.

And in Q2 we broke ground on a dedicated biologic clean room in Burlington. As to our third headline, our three biologic grafts had record quarters in Q2. Omniflow II and ProCol, each grew 19% and Q2 results for RestoreFlow were 64% above its pre-acquisition revenues. On May 18, we obtained RestoreFlow approval from Health Canada.

Biologics accounted for 34% of our sales in Q2, a high watermark. I will now turn the call over to JJ..

Thanks, George. Q2 2017 operating income was $5.5 million, an increase of 46% versus Q2 2016. The increase was driven by a 15% improvement in sales, as well as tight expense control. Cost containment efforts initiated a number of months ago are now bearing fruit and operating expenses in Q2 2017 were up only 3% versus Q2 of 2016.

On a sequential basis, expenses declined $1.2 million from Q1 to Q2. As reflected in our guidance, we expect an operating margin of 21% for the full year 2017, up from 18% in 2016. Our effective tax rate in Q2 2017 was 15% with a lower rate driven largely by increased employee stock option exercises.

Combined with the 46% increase in operating income, reduced tax rate resulted in net income of $4.6 million, a 78% year-over-year increase. Earnings per share in the period was $0.23, a 69% increase. We finished Q2 2017 with $30.1 million in cash, an increase of $4.3 million from Q1 2017.

Cash increases in the quarter were driven by cash from operations of $5.4 million, as well as receipts from stock option exercise of $1.5 million. Turning to guidance. We expect Q3 2017 sales of $25.4 million, a reported increase of 10% and 3% organically.

We also expect a gross margin of 70% in the quarter, operating income of $5.1 million and earnings per share of $0.20. As you may recall, in Q3 2016, we benefitted from a significant competitor back order. For the full year 2017, we have increased our sales guidance to $101.9 million, or a recorded increase of 14% and 8% organically.

We now expect full year gross margin of 70% and have increased our operating income guidance to $21.1 million, an increase of 29% and earnings per share to $0.79, an increase of 44%. In closing, I would like to thank Charles Haff of the firm Craig-Hallum for recently initiating coverage on LeMaitre.

We look forward to working with Charles in the coming quarters. Separately we are pleased to note that in May we were added to the S&P 600 Small Cap Index. With that I will turn the call back over to Heather for questions..

[Operator Instructions] Our first question comes from the line of Jason Mills with Canaccord. Your line is open..

So I wanted to start with phenomenal profitability. You preannounced the top line, and I am sorry I bounced between a couple of calls so you have probably gone over this. But maybe it's so good, perhaps worth going over a little bit more. What is driving in terms of operating margin? Really the efficiencies you have shown in your business.

I would love for you to go over a little bit more and what that portends going forward? Your guidance for the year, obviously a little over $100 million in revenue and obviously where you are now with your Op income guidance. We are sitting right there at 20% operating margins. Your gross margins, while a little weak are still 70%.

Much better than medtech averages. Maybe you could comment on, as you look forward with your 10 and 20 objectives, where we start to see maybe a little bit of law of larger numbers making it harder to grow operating margins.

Because you are sort of implying next year we are going to be into the [indiscernible] 20s operating margins, which is obviously not something many medtech achieve..

Okay. So, Jason, first of all thanks for the question. There were a lot of questions resident in there and I am grappling with where to start. Maybe I start at the end and then maybe you guide me through which other questions you want. You are talking about operating margins and I would guess, yes, we are feeling real excited about our op margins.

We went from 15% in 2015 to 18% in 2016 and now we are guiding at 21% for 2017. So of course we are thrilled. We never thought we get to these levels way back then and so we are excited about what's happening.

As far as the 10, 20 goes and as it relates to op margin next year and the year after, you know we have been pretty hesitant to put numbers around op margins but of course any one on the call can do the math, which is 10 and 20 indicates operating leverage continues and I think you got three guys here, me JJ and Dave, who would not open our mouth about 10, 20 unless we believed in it.

And you have heard 10, 20, we were looking back, I think the 10, 20 got started in our press releases about two and three quarters years ago. So we are still on that. We still feel really good about it and for the foreseeable future that too we think we are.

That all being said, of course the law of large numbers that you are talking about, we laugh around here that 10, 20 is a cruel task master. It makes you push hard and you can see that in the cost cutting, you hear about it even though things are going great guns here. We are still out there working cost cuts and things like that.

We are conscious that we are on the hook for 10, 20 but we feel very comfortable about being on the hook for 10, 20..

Got it. And so I guess as a segue, sorry for the multiple part question there, but maybe talk about the gross margin contribution as we think about everything flowing through to the bottom line. Gross margins are solid. They did come down a little bit.

Where do they go over the next couple of years given the mix in your business and I guess more specifically, you have talked about the new clean room for biologics.

I am wondering if there is a margin impact in the near-term from that initiative and ultimately drives better gross margins over the longer-term perhaps talk about that as a specific with the broader conversation of gross margins going forward..

All right. So, Jason, I am going to talk high level a bit about your question, then I am going to pass it over to JJ who has a better hand along some of the tighter details of this. But I will say, yes, Q2 wasn’t our finest hour gross margin wise.

I look at that as an opportunity as the year goes on and as next year goes on, because we did all of this, this amazing quarter with the 68% gross margin. And I think everyone on the call knows that we are capable of doing better.

In fact, to go back a couple of years, I think in 2014 we had a 68% gross margin and its come up to 70% over those three years despite a highly dilutive acquisition called RestoreFlow and another dilutive acquisition called ProCol. Both of those happened in 2016.

So LeMaitre's sad or serious story is is that we keep building the gross margin and it keeps getting beat up by the things that we buy and then we go back and we repair them. But that trip from 2014 where we had a 68% gross margin to 2017 where we are guiding a 70% gross margin.

That’s 300 basis points and then we lost another 200 basis points to FX over that time. So the company despite those negatively accretive, dilutive acquisitions, in terms of gross margin, has been able to pick up 500 basis points.

We are going and we are working on it but unfortunately as we keep buying things, we are never really going to be promising you guys something way beyond 70% Because we keep buying in thins, it's really hard to find companies at the size we are buying that are more than 40%, 30%, 50% gross margin. We need to fix them and it takes time.

So that’s a high level look at it.

Maybe JJ can, if I missed some details there?.

Yes. No. Jason, if you have seen that Slide on our corporate presentation with the 10-year look back on the gross margins, I think we made it five or six years more recently but sort of flipping in and around that 70% range and when we do an integration, we bring an acquisition from wherever it is into our facility, we usually take a hit.

Or when we do an acquisition that generally has a lower gross margin than ours, then we repair it pretty quickly as we get those things centralized and you see the recovery. But if you squint over the course of ten years, you are sort of at that 70% range.

So I would say more specifically, related to the first two quarters, Q1 was a little bit of an anomaly at about 72% for gross margin, sort of surrounded by 69.5% and now a 68%.

And in Q1 we had some efficiencies from prior periods coming on to the P&L from the balance sheet and they also had to conspire at the same time to come on and do nice things in Q1 and that helped that a lot until the comparison to Q2 and the results of Q2 wasn’t as impressive, if you will, versus Q1.

We also has some HYDRO rework items that we took care of in Q2. And then the mix from RestoreFlow and ProCol as those guys grow, they are certainly going to be a drag on our gross margin and we will fix those margins over time.

But since they are relatively new acquisitions, those margins typically have lower margins than our corporate average, if you will. So that’s all sort of what conspired in Q2 to bring us down to 68%. But we are thinking in the next quarter maybe a rebound to 70% as some of those manufacturing inefficiencies, if you will, in Q2 level out.

And maybe the FX piece actually helps us going forward, I think we are 116 or 116.5 for the euro/dollar right now. So that’s going to help the margin a little bit. And we have got a few little price increases coming through as well in Q3 and Q4 that will help also.

So I think a little rebound here to the norm of 70% as sort of what we are looking at for Q3 in the back half of the year..

That’s helpful. And that was great color because you gave us sort of -- you are reminding of the ten-year look back. And on a go-forward basis, George, you have talked about M&A is going to be, continue to be part of your strategy. You are also going to continue to fix things and improve margin.

So obviously you are not giving us next year's guidance, so let alone ten years from now.

But squinting forward a few years, it sounds like what you are telling me as you are going to continue to drive the operating margin, but as you acquire things that maybe a bit dilutive in the near-term, while you are fixing things and driving the organic business to higher margins that we should be sort of comfortable here in and around the 70% level.

Maybe a little bit of accretion to that but not much. And then really leveraging it to the operating margin line. Is that a fair way to think about more the medium term next two, three years..

It is, Jason. And I would just -- you say we are not guiding but we are. We are saying 10, 20 and you have the three of us on the call saying 10, 20..

I would, Jason, just as a little more color. Because we are geographically diversified and because we do a lot of acquisitions, mix affects the gross margin and obviously acquisitions do as well quarter-to-quarter.

So we have maybe a little more volatility in our gross margin line quarter-to-quarter but over the years I think that the answer is pretty constant..

[Operator Instructions] Our next question comes from Chris Lewis with ROTH Capital Partners. Your line is open..

George, even though it seems like this question gets asked almost every quarter but I am going to ask it again. So just on XenoSure, another really strong quarter. Maybe you can just kind of update us on what continues to drive the growth in that product.

How are you seeing the growth rates differ between North America and internationally and potentially the growth prospects for each of those markets going forward? Just any additional color you can provide around XenoSure would be helpful..

Sure. Okay. And so I notably remember back in February we were talking about the Rubik's Cube of what's this thing going to grow this year.

And so maybe what we -- and I think we have more clarity on now and at a very high level we can say it feels like on a reported basis it's going to be about a 25% number this year but on a organic basis it's going to be about 30% this year.

That’s 30% what you saw in Q2 and we think is -- sorry, 25% reported in the year, those numbers are roughly split three-quarters units and one-quarter price. And if you are looking for the split international versus domestic, it feels more domestic because we discovered pricing power domestically but we haven't discovered pricing power o-U.S..

Okay. That’s helpful. And then just in terms of RestoreFlow. Can you quantify what the contribution was for sales in the quarter and just more broadly, just how that product is tracking at this point in the year relative to your original expectations..

Sure. We sold -- tissue preservation services is what you are supposed to call it, was 1.5 in Q2. So you can annualize that sort of towards the $6 million number. We bought a $3.7 million LTM business in November of '16. So I think you can start saying, gosh, that feels pretty good. Editorially, the sales reps are very excited about this device.

They are not always right but on this one they have voted pretty quickly. They are very excited about the device. We feel great about its sales life. I think from a contribution perspective, it's really not contributing much out.

I would say you can think breakeven, you can think a margin and we are spending some stuff out there on admin and things like that. So it's not something that’s helping us profit wise but it is something that’s helping us sales wise..

Okay. Great. And then just finally. In terms of sales management, you have had some turnover recently in the North America and in Europe. Now I think it will be helpful for investors as this is the question I am sure a lot of the analysts are getting.

But just kind of what your expectations are given kind of that sales leadership transition period and how the search is progressing to find new people to take over. Thanks..

Okay. Yes, definitely. And I will tell you, this will be a tale of two continents here. One is in Europe, where you have a guy for 20 years who is just retiring. He is 63 or 64 and he is retiring. Sincerely well telegraphed to the board and me over the years. He is still in this seat until September 30.

We have a launched a search to replace him and I will be in Frankfurt all next week interviewing candidates for that job. Who knows when that will fill. We will fill it when we find the right candidate. That one is a much more orderly transition in that it wasn’t forced on us quickly.

We have seven regional managers over there who have been with us for, pick a number, five or eight years, and I have very close contact with them. So in the interim I will play VP of Sales over in Europe. But we expect to fill the job at some point. And so that’s going normal on the transitions. Well, telegraphed. Everyone knows it's going on over there.

In the U.S. you had a fellow who worked here for 22 months and then quit abruptly with a five-day notice. So it was a little bit less well telegraphed to me.

I am lucky in that amazingly for the first six months, and you mentioned turnover, the only turnover in the entire worldwide sales force, the only voluntary turnover was actually Mike Wijas, VP of Sales. So we didn’t lose one rep. we don’t lose one RSM. And that goes globally. But if you want to look into the U.S.

portfolio of reps and managers, you remember that between the time I terminated the previous VP of Sales and Mike, the fellow who just left, there was a five month period where I was VP of Sales. So I expect I will reprise this role. And all the managers are the same except for one guy who Mike hired.

One of the seven is a new manager who has been there two years now and the rest of them are -- year and half and the rest of them have been there for 5 and 12 years and I have been their manage intermittently over the years. So in the U.S. it's much easier for me. It's much more homogenous system. I feel very comfortable in the role as VP of Sales.

In Europe it is a little more complex. It's a little less homogenous but I think the process in filling it and Peter being there through September 30, makes that a little bit less nerve racking.

And then in the end Chris, I would just say, it's all baked in the guidance so you can hear we have now had a month or so to think about what does Mike and Peter's departure mean to us. And I think if anything, we largely kept guidance the same, with change for FX and change for the [beat] [ph].

So it's not changed our view of this year and on a bottom line I think the show continues and I think our cost cutting has been a little bit more effective than we had thought it would be this quickly, so we are able to share some of those earnings with the guidance change on that topic..

Thank you. And your next question comes from Joe Munda of First Analysis. Your line is open..

So first question. In regards to the clean room, can you give us timeline as well as expected cost surrounding that, as far as when we could expect construction to be completed and total cost involved. Thanks..

Yes. So, Joe, there is two clean rooms actually that have been in process. One is an expansion of our existing main clean room where the majority of our products are manufactured. And that was probably $1 million to $1.5 million endeavor. And that’s turned on already over the last few weeks or so.

And when we are working, as you know, on a biologic clean room. And that will probably be $2 million to $2.5 million project. And I am going to guess that turns on sometime in Q4 and that timing couldn’t shift forward a little bit maybe but I am going to guess it's in that timeframe.

And the two of them combined are probably initially maybe are going to have an impact to the gross margin of around 0.5%. And, Joe, that’s obviously baked into guidance..

Okay. You answered my question. George, in terms of XenoSure and the competitive landscape. You had third quarter last year, did get one time sort of advantage because of a competitor. What are you seeing in the competitive landscape as far as that product is concerned.

Is the competitor de-emphasizing that product or can you explain, I guess some of the dynamics you are seeing in the space..

So I think the competitor which is Baxter as we all know, has sort of been the same the whole time and I just continue to think that our call point is more valuable than theirs. We are the vascular surgeon company, these things get sold to vascular surgeons. And so we just keep going.

We are trying to point out for everyone that in Q2, we almost got up to the Q3 high point which is all these free sales from Baxter in Q3 of last year. This Q2 coming around three quarters later we have almost made it to that level. So, yes, comp wise, it's going to be a little difficult.

But I mean the package of LeMaitre and XenoSure keeps rolling on. It's feel great right now. And I would say we even have a place to go. I know I keep talking about this. These are long approvals but Australia and China and Japan, Korea and Taiwan, these markets will come on at some point.

And you sort of have 20% of the world to give there and then even then I feel like it's a $75 million market. Dave knows these numbers better.

What do we call in this market and what's it growing at?.

$80 million market, growing I would say, mid-single digit. Driven by infection resistance..

And Joe, we had 18 of that 80 last year. And you can stick a 25% number on top of that 18 as we mentioned here on the call..

Okay.

So as far as Australia and China coming on, any idea as far as what that could look like?.

Yes. Size wise, I will be less specific. I just know it will wind up being our best product in all those markets when it gets online. It's certainly bigger than the Valvulotome, it's certainly bigger than what we have out there. Timing wise, which may have been your question. Australia is the one with the most visibility.

We labored over that application so we are closer to understanding that. It's not a clinical trial. It's a plain old application and we feel like it's an 18 months at the outside approval. And I don’t think there is that many hurdles. This thing should pass but we will leave that up to the Australian regulators to decide.

The Chinese one, as you heard before, after many delays we finally got our first couple of implants. We are going to see over the next month or three how quickly this thing starts enrolling, given that we have now broken through every single one of those bureaucratic hurdles. But we are still seeing something like 2021 approval.

But honestly, there is a lot of back and forth between here and there. That’s a long way away. I would be surprised if all the shareholders on this call still own the stock in four years..

Okay. And then I guess my final question will be on the rep count.

Any significant change over Q1?.

No. I think I have mentioned before that we terminated two reps in [indiscernible], so we are down from 95 to 93. And we have job requisitions out there for three more to hire. So we are not really trying to go down right now, we are just trying to get at the underperformers and sort of move forward..

Thank you. [Operator Instructions] Our next question comes from [indiscernible] with Stifel. Your line is open..

This is [Gerona] [ph] for Rick tonight. I just had a question on your thoughts for your portfolio. So you have 15 product lines right now, about $900 million addressable market, which is still a lot of runway in the products. And you are participating in the $5 billion peripheral vascular market.

Just as you think about your internal development pipeline and acquisition strategy, do you need to get up to 20 or 25 products in the bag to continue your 10% top line growth over the next three to five years and do you feel like a need down more than in the past to push more into endovascular versus open procedures..

It's, Dave. That’s a good question. I would say at a high level, no. We don’t feel like we need to get to 20 or 25 product lines. As you pointed out, our addressable market now is around $800 million or $900 million. And of course we have about $100 million in sales. So what do we have, like 12% or 15% share of the addressable market.

So certainly with the existing portfolio, we could grow a lot. That being said, there are a lot of interesting product opportunities that we don’t currently offer in our bag. I would say that center of the fairway for us still is open vascular. Bu we also like endovascular for sure. It would leverage our call point very well.

And then we also look beyond arterial work into maybe venous or varicose vein, or dialysis access. Those are, to mix metaphors, zip codes right next door.

So I think there are a lot of opportunities for us in terms of products but, no, I don’t feel like 20 or 25, I feel like at 15 we could maybe add a few or five more and have plenty of room to grow for years. At the end of the day, a typical sales rep has trouble focusing on more than five or maybe seven products in the bag.

So you just need to get a really good suite of five or seven core products I would say..

And just as a reminder, your sales forces is incented to, on the gross margin side not on revenues.

Is that correct?.

That’s right. All 93 reps have gross profit plans not sales plans..

Okay. And just lastly.

Could you just maybe update us on kind of how you see growth in, maybe in your total addressable market now?.

Sure. So the total addressable market now, again, our bag is centered mostly on open vascular which we feel is conversing as a total market. Could be flat, could be growing a little bit. We have grown primarily from taking share.

But as endovascular growth rates come back down to earth and now we are turning to sort of mid and low-single digits as we have seen. We have seen some uplift in the open vascular surgery growth rate. So I think we are in a market that’s growing maybe low single digits, possibly more than that. But generally in that range.

And we are taking share and we are growing units also by going into new geographies, getting approval and selling in places like China and other countries..

Thank you. And our next question comes from Lucas Baranowski with Craig-Hallum Capital. Your line is open..

Yes. This is Lucas Baranowski on for Charles Haff. And my question relates to Omniflow and ProCol. You know we had been thinking about those as more like mid-single digit growers. But from the comments in the prepared remarks, it sounds like they have accelerated a bit.

So is there any color you can give us on what's happening in those markets?.

Hi, Lucas and a special welcome to Craig-Hallum to the team. We are real excited about your guys covering us. So thanks for the great question here. Yes, actually Omniflow, I think we bought that in August of '14 and I think initially we sort of shared your baseline expectations to that product line.

And it's gone swimmingly in Europe over the last -- it's only available in Europe effectively and Canada. And it's gone swimmingly and again that 19% I think we quoted on the call today, that’s kind of a new normal number for that product line and it is basically all Europe and Australia as well. So, yes, we have had it for a couple of years.

It's exceeded our expectation. I think we bought about $2.5 million business back then and I think it's about $5 million business right now. In terms of ProCol, we have a lot less information on that. We just lacked the one year time after we acquired it. We happen to have a really nice Q2. It was sort of a standout Q2.

So I wouldn’t put all my reputation on the line saying we know we have discovered a winner there. They had a nice quarter. It had a couple of medium quarters before that. So we will see, we will take a watchful eye on that but Omniflow, we are starting to get really excited about around here.

So we now have, I would say the excitement is centered around RestoreFlow in the U.S. and Omniflow in Canada and Europe..

Okay. Thank you. That’s very helpful. And then when we kind of look at that gross margin being below 70% this quarter. I mean is it safe to say that it was really the growth that you saw in these biologic grabs. The Omniflow, the ProCol and the RestoreFlow, that was the reason. It wasn’t at 70% this quarter.

I mean if those had grown more like they did last quarter, would it have been 70%?.

Thanks for the question. They definitely have an impact on the reported corporate number. It depends what timeframes you are comparing. But year-over-year certainly the impact is significant, probably around 2% negative to the margin because of the introduction of those products.

And then as they grow sequentially, it will be a drag as well until we start fixing that.

So I would say, yes, a lot of work to do on fixing that gross margin like we typically do with our acquisitions and that will happen over time but in the meantime, yes, those margins are definitely lower than corporate and they definitely have a drag on the answer..

And JJ, could I add in that maybe a little of that is driven by the purchase accounting from the inventory that we got at the acquisition. So when we bought RestoreFlow in November of last year, we got a year, maybe a little bit more of inventory. And when bought ProCol in March of last year, we got two years worth of inventory.

So of course when you acquire inventory, the margin we get on that is probably in the 30% range. We have to sell all of that through before we start to get the full corporate gross margin on the products that we manufacture internally..

Thank you. And I am showing no further questions at this time. Ladies and gentlemen, that concludes the conference for today. I would like to thank you for your participation. You may now disconnect and have a great day..